The Choice between Decentralization and Centralization

The choice between centralization and decentralization is not absolute. Frequently it makes sense to centralize some decisions and decentralize others, depending on the type of decision and the firm’s strategy. Although the choice between centralization and decentralization depends on the circumstances being considered, a few important generalizations can be made.

First, decisions regarding overall firm strategy, major financial expenditures, financial objectives, and legal issues are centralized at the senior management level in most organizations. Operating decisions, such as those relating to production, marketing, R&D, and human resource management, may or may not be centralized depending on the firm’s strategy and conditions in the external environment.

Second, when the realization of economies of scale is an important factor, there tends to be greater centralization. Thus purchasing and manufacturing decisions are often centralized in an attempt to eliminate duplication and realize scale economies. In contrast, sales decisions tend to be more decentralized because economies of scale are less of a consideration here.

Third, when local adaptation is important, decentralization is typically favored. Thus when there are substantial differences between conditions in local markets, marketing and sales decisions are often decentralized to local marketing and sales managers. Many multinational consumer products firms, such as Unilever, centralize decisions about manufacturing and purchasing to realize scale economies, but decentralize marketing and sales decisions to local brand managers in different countries because competitive conditions differ from country to country and local adaptation is required.

Finally, decentralization is favored in environments that are characterized by high uncertainty and rapid change. When competitive conditions in a firm’s market are changing rapidly, with new technologies and competitors emerging and conditions changing in ways that are difficult to anticipate, centralization, because it slows down decision making, can put the firm at a competitive disadvantage. This is why many high-technology firms operate with a greater degree of decentralization than firms operating in more stable and predictable environments.

At Google, for example, lower-level employees are given explicit permission to develop new business ideas and the right to lobby top managers for the funds to develop those ideas. Such decentralization of strategy making would not be found in firms operating in a more stable and predictable environment, such as the automobile industry. A vivid example of the costs of making the wrong choice between centralization and decentralization occurred in 2005, when the Federal Emergency Management Agency (FEMA) had to respond to the devastating impact of Hurricane Katrina on New Orleans. The hurricane flooded much of New Orleans and resulted in a mandatory evacuation of the city. FEMA, the federal agency responsible for disaster response, was widely criticized for being very slow to help the hundreds of thousands of mostly poor people who had been made homeless. For several days while thousands of homeless people huddled in the New Orleans Superdome, lacking food and adequate sanitary facilities, FEMA was nowhere to be seen. Later analysis revealed that one reason for FEMA’s slow response was that the once autonomous agency had been placed under the direct supervision of the Department of Homeland Security after September 11, 2001. FEMA officials apparently felt that they had to discuss relief efforts with their superiors before proceeding. This cost the agency crucial hours in the early part of the disaster, which significantly slowed its response and meant that the relief effort was less effective than it might have been.

Date: 2015-01-12; view: 1145